Price charts often have blank spaces known as gaps, representing times when no shares were

traded within a particular price range. Usually this occurs between the market close and the next
trading day's open. There are two primary kinds of gaps—up gaps and down gaps.

For an up gap to form, the low price after the market closes must be higher than the high price of
the previous day. Up gaps are generally considered bullish.

A down gap is the opposite of an up gap; the high price after the market closes must be lower
than the low price of the previous day. Down gaps are usually considered bearish.

Gaps result from extraordinary buying or selling interests often developing while the market is
closed. For example, if an unexpectedly strong earnings report comes out after the market has
closed, a lot of buying interest will be generated overnight. This results in an imbalance between
supply and demand. So, when the market opens the next morning, the stock price rises in
response to the increased demand from buyers. If the stock price remains above the previous
day's high throughout the day, then an up gap is formed.

Gaps can offer evidence that something important has happened to the fundamentals or
psychology of the crowd that accompanies the price movement.
Timeframe of Gaps
Up and down gaps can form on daily, weekly, or monthly charts and are considered significant
when accompanied by above average volume.

Gaps appear more frequently on daily charts—every day presents an opportunity to create an
opening gap. Gaps on weekly or monthly charts are rare. If you're looking at a weekly chart, the
gap would have to occur between Friday's close and Monday's open. If you're looking at a
monthly chart, the gap would have to be between the last day of the month's close and the first
day of the next month's open for monthly charts.
A price chart with gaps that occur almost daily is typical for thinly-traded securities and should
probably be avoided. Prices often gap up or down at market open, but the gap does not last until
the market closes. Such temporary intraday gaps should not be considered as having any more
significance than normal market volatility.

Types of Gaps

Gaps can be subdivided into four basic categories:

 Common Gaps
 Breakaway Gaps
 Runaway Gaps, and
 Exhaustion Gaps

What Are Common Gaps?

This type of gap is sometimes referred to as a trading gap or an area gap. Common gaps are
usually uneventful. They can be caused by a stock going ex-dividend when the trading volume is
low. These gaps are common (get it?) and usually get filled fairly quickly.

“Getting filled” means that the price action at a later time (a few days to a few weeks) usually
retraces, at the least, to the last day before the gap. This is also known as closing the gap. Below
is a chart of three common gaps that have been filled. Notice how, following each gap, the price
retraced to where the gap started. In other words, the gap has been filled.
A common gap usually appears in a trading range or congestion area, reinforcing the apparent
lack of interest in the stock. This is often further exacerbated by low trading volume. Being aware
of these types of gaps is good, but it's doubtful that they will produce trading opportunities.

What Are Breakaway Gaps?

Breakaway gaps are exciting. These occur when the price action is breaking out of a trading range
or congestion area. To understand gaps, you have to understand the nature of congestion areas in
the market.

A congestion area is a price range in which the market has traded for some time, usually a few
weeks or so. The area near the top of the congestion area is usually a resistance area when
approached from below. Likewise, the area near the bottom of the congestion area is a support
area when approached from above. To break out of these areas requires market enthusiasm and
either many more buyers than sellers for upside breakouts or many more sellers than buyers for
downside breakouts.

Volume will (should) pick up significantly from the increased enthusiasm and also because many
are holding positions on the wrong side of the breakout and will need to cover or sell them. It's
better if the increase in volume happens after the gap occurs. This means that the new change in
market direction has a chance of continuing. The point of the breakout now becomes the new
support (if it's an upside breakout) or resistance (if it's a downside breakout). Avoid falling into
the trap of thinking this type of gap, if associated with good volume, will be filled soon. It might
take a long time for the gap to be filled. Instead, go with the thought that a new trend in the
direction of the stock has taken place and trade accordingly.
Notice in the chart below how prices spent a few weeks consolidating. Prices broke above
resistance at low volume and pulled back. The following breakaway gap took place with high
volume, indicating a significant bullish shift in sentiment and triggering the start of a new
uptrend.

Price gaps associated with classic chart patterns tend to be stronger than those that aren't. For
example, an ascending triangle with a breakaway gap to the upside can be a much better trade
than a breakaway gap without a good chart pattern.
What Are Runaway Gaps?
Runaway gaps are best described as gaps caused by increased interest in the stock. Runaway gaps
to the upside typically represent traders who didn't get in during the initial move of the up trend
and, while waiting for a retracement in price, decided it would not happen. Increased buying
interest happens suddenly, and the price gaps above the previous day's close. This type of
runaway gap represents a near-panic state in traders. Also, a good uptrend can have runaway
gaps caused by significant news events that cause new interest in the stock. In the chart below,
note the significant increase in volume during and after the runaway gap.

Runaway gaps can also happen in downtrends. This usually represents increased stock liquidation
by traders and buyers standing on the sidelines. Those holding the stock will eventually panic and
sell. But sell to whom? The price has to continue to drop and gap down to find buyers. Not a
good situation.

The term measuring gap is also used for runaway gaps. It isn't easy to find examples for this
interpretation, but it's a way to help decide how much longer a trend will last. The theory is that
the measuring gap will occur in the middle of, or halfway through, the move.

Sometimes, the futures market will have runaway gaps caused by trading limits imposed by the
exchanges. Getting caught on the wrong side of the trend when you have these limit moves in
futures can be horrifying. The good news is that you can also be on the right side of the trend.
These are not common occurrences in the futures market, despite all the wrong information
being touted by those who don't understand it (and are only repeating something they read from
an uninformed reporter).
What Are Exhaustion Gaps?
Exhaustion gaps happen near the end of a good up or downtrend. The gaps are often the first
signal of the end of that move. They're identified by high volume and a large price difference
between the previous day's close and the new opening price. They can easily be mistaken for
runaway gaps if you overlook the exceptionally high volume.

It is almost a state of panic if the gap appears during a long down move where pessimism has set
in. Selling all positions to liquidate holdings in the market is not uncommon. Exhaustion gaps are
quickly filled as prices reverse their trend. Likewise, if they happen during a bull move, some
bullish euphoria overcomes trades, and buyers cannot get enough of that stock. The prices gap
up with huge volume; then, there is great profit taking, and the demand for the stock dries up.
Prices drop, and a significant change in trend occurs (see chart below for an example of an
exhaustion gap).

After the stock price jumped, it lost momentum, as bulls might have suspected that price was
overvalued. This sentiment continued for two weeks, after which prices resumed trending
upward.
Final Thoughts
The adage that all gaps eventually get filled might not always hold true, especially in the case of
Breakaway and Runaway gaps. Waiting for breakout or runaway gaps to be filled can devastate
your portfolio. Similarly, waiting for prices to fill a gap before getting on board a trend might
make you miss a big move. So, instead of waiting for gaps to be filled, you may be better off
focusing on the message gaps convey about market dynamics. Gaps are a significant technical
development in price action and chart analysis

End